Global risk and demand for gold by central banks

Abstract

This paper examines the influence of global risk on the holding of gold by central banks based on annual data for 100 countries during 1990-2015. We use a dynamic panel generalized method of moments (GMM) model to estimate this effect, controlling for a variety of domestic factors. Consistent with portfolio diversification and perception of gold as a safe asset, we find that the gold holdings of central banks increase in response to higher global risk. This effect is larger for high-income countries than for developing countries. Moreover, greater capital account openness is associated with a stronger response of central banks’ gold holding to global risk, while a higher ratio of overall reserves to imports is associated with a weaker response. We also find evidence that the sensitivity depends on whether the currency regime followed is fixed or floating, with higher responsiveness in the case of fixed rate regimes. The baseline results are robust to alternate estimation methods, exclusion of crisis years, active and passive management of gold reserves and additional controls. These findings suggest that central banks adjust their gold holdings in response to changes in global risk conditions, with the magnitude of response depending on reserve management capacity and country-specific vulnerabilities.